FINANCIAL ANALYSIS

FINANCIAL MANAGEMENT. FIN 3513

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 01 Explain on components
and users of financial
statements
02 Explain the importance
and types of financial
ratios
03 Calculate financial ratios
based on information in
financial statements
LEARNING 04 Analyzed the financial
performance based on
OUTCOMES ratios calculated

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 FINANCIAL STATEMENTS
Statement of
Financial
Position
02

Statement of
04 Cash Flow
01
Statement of
Comprehensive Statement of 03
Income Notes to the
Changes in 05 Accounts
Equity

Statement of Comprehensive Income presents the financial performance

of the organization over a period of time. On a gross basis, the statement
depicts a picture of direct expense, indirect expense and capital (through
depreciation) expense over the period.

Statement of Financial Position shows the company’s financial position

at the end of the financial year. The financial position means
quantification of the assets, liabilities and equities of the owners as on a
specific financial period.

Statement of Changes in Equity is a statement of changes in

shareholders equity presents a summary of the changes in shareholders’
equity accounts over the reporting period. It reconciles the opening
balances of equity accounts with their closing balances.

Statement of Cash Flow shows the sources form where the organization

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generates its cash & where it expends. The net cash movement from all
activities is then added to the beginning cash & cash equivalents to
arrive at the closing cash & cash equivalents.

Notes to the accounts disclose the detailed assumptions made by

accountants when preparing a company’s financial statements. The notes
are essential to fully understanding these documents.

Financial statements are very important as it accurately reflects business

performance and financial position of the company. Additionally, it helps
all stakeholders including management, investors, financial analyst etc. to
evaluate and take suitable economic decisions by comparing past and
current performance and therefore predict future performance and
growth of the company.

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 USERS OF FINANCIAL STATEMENTS

Shareholders Creditors

Management Employees

The shareholders provide funds or capital for the organization. They possess
curiosity in knowing whether the business is being conducted on sound lines
or not and whether the capital is being employed properly or not.

The management of the business is greatly interested in knowing the position

of the firm. The accounts are the basis, on which the management can study
the merits and demerits of the business activity.

Creditors are interested to know the financial soundness before granting

credit. The progress and prosperity of the firm, to which credits are extended,
are largely watched by creditors from the point of view of security and further
credit.

The demand for wage rise, bonus, better working conditions etc., depend
upon the profitability of the firm and in turn depend upon financial position.
For these reasons, the employees of the company are interested in financial
statements.

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 USERS OF FINANCIAL STATEMENTS

Investors Consumers

Stock
Government
Exchange

The prospective investors of course wish to see the progress and prosperity of
the firm, before investing their money, by going through the financial
statement of the firm for the purpose of safeguarding the investment.

Government keeps a close watch on the firm which yield good amount of
profits. The state and central governments are interested in the financial
statements to know the earnings for the purpose of taxation.

Consumers are interested in getting the goods at reduced price. Therefore,

they wish to know the establishment of proper accounting control, which in
turn will reduce the cost of production, in turn less price to be paid by the
consumers.

The financial statements are the blueprints of financial affairs. These

statements facilitate the stock exchange to protect the investors’ interests or
to watch as a watch-dog of corporate investors.

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 OVERVIEW
Financial analysis
enable users to understand a
firm’s financial position and its
performance

Financial ratios
help users to identify a
firm’s financial strengths
and weaknesses

Financial analysis encompasses financial ratio analysis. Financial

statements present information to its readers about a firm’s financial
position. However, not every relevant information may be obvious to a
reader from the financial statements until some form of restatement of
the financial information in some form of relative term is done. This is
known as financial ratios. Financial ratios therefore help readers to
identify the financial strengths and weaknesses of a firm.

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 RATIO
COMPARISONS

Historical Budget
analysis analysis

Competitive
analysis

Historical analysis looks at a ratio of a firm from one period and

compare it to the ratio from a similar prior period.

Budget analysis is comparing company’s actual financial ratios to the

projected ratios set up at the beginning of the financial period.

Competitive analysis compares company’s financial ratios with the one

from a company in the same industry or the industry average.

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 ADVANTAGES OF RATIO ANALYSIS

Useful in financial Useful in forecasting

01 position analysis 04 purposes

Useful in simplifying Useful in locating

02 accounting figures 05 business’s weaknesses

Useful in assessing the Useful in comparison

03 operational efficiency 06 in performance

Financial ratios reveal the financial position of the concern. This helps
the banks, insurance companies and other financial institutions in
lending and making investment decisions.

Financial ratios also simplify, summarize and systematize the accounting

figures in order to make them more understandable and in lucid form.
They highlight the inter-relationship which exists between various
segments of the business as expressed by accounting statements.

Apart from that, financial ratio helps to have an idea of the working of a
concern. This helps the management to assess financial requirements
and the capabilities of various business units.

If financial ratios are calculated for a number of years, then a trend is

established. This trend helps in setting up future plans and forecasting.

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Financial ratios are of great assistance in locating the weak spots in the
business even though the overall performance may be efficient.
Weakness in financial structure due to incorrect policies in the past or
present are revealed through financial ratios.

Through financial ratios, comparison can be made between one

departments of a firm with another of the same firm in order to evaluate
the performance of various departments in the firm.

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 GROUP OF RATIO ANALYSIS

Liquidity ratios

Leverage ratios

Profitability ratios

Efficiency ratios

Market value ratios

Liquidity ratios seeks to answer the question as to the extent to which the
firm has adequate cash flows or assets that are near to cash that would be
sufficient to meet the short-term liabilities of the firm.

Leverage ratios seeks to investigate how a firm is being financed and provide
indicators as to the extent a firm can meet the interest payments.

Profitability ratios seeks to answer the question as to whether the

management of the firm is generating adequate profits from the use of the
firm’s capital and assets.

Efficiency ratios provide investors with information to which the management

of the firm has been efficient in ensuring that the business earns sufficient
returns to its providers of finance, debt and equity.

Market ratios are based on information that is based on the market price of a
firm’s share.

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 LIQUIDITY RATIOS

Current ratio
= current assets
current liabilities
Net working capital
= current assets – current liabilities

Acid test ratio (quick ratio)

= current assets – inventory – prepayment
current liabilities

Net working capital is current assets less current liabilities. When current
assets exceed current liabilities, the firm has positive net working capital
and if it is the other wat round, it has negative net working capital.

Current ratio compares the ratio of current assets to current liabilities. It

basically indicates the extent of firm’s liquidity.

Acid test ratio measures the ratio of current assets less any currents
assets that is deemed to be difficult to converted into cash, like
inventory, to current liabilities.

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 EXAMPLE
The following is the Statement of Financial Position for Company A as at 31 March 2020:

ASSETS RM LIABILITIES AND RM

EQUITIES
Land and buildings 140,000 Share capital 200,000
Plant and machinery 350,000 Retained earnings 30,000
Inventory 200,000 Reserve 40,000
Account receivables 100,000 12% debentures 420,000
Other receivables 10,000 Account payables 100,000
Cash 40,000 Other payables 50,000
840,000 840,000

Calculate:
a) Net working capital
b) Current ratio
c) Acid test ratio

a) Net working capital = Current assets – current liabilities

= RM350,000 – RM150,000
= RM200,000

b) Current ratio = Current assets / Current liabilities

= RM350,000 / RM150,000
= 2.33 times

c) Acid test ratio = Current assets – inventories

Current liabilities
= RM350,000 – RM200,000
RM150,000
= 1 time

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 GEARING RATIO
Equity ratio Debt ratio
= shareholders’ equity = total liabilities
total assets total assets

Debt-to-equity ratio Times interest

= long-term debt earned ratio
total equity = earnings before interest and tax
interest expenses

Equity ratio represents the proportion of shareholders’ equity to total assets.

A higher ratio denotes that shareholders have provided significantly enough
funds to purchase the assets of the concern instead of relying on other
sources of fund.

Debt ratio determines the ratio of liabilities and the assets of a firm. It
demonstrates how risky it would be for a provider of debt finance to extend a
loan to the said firm, with a higher ratio indicating greater risk.

Debt-to-equity ratio is calculated by dividing a company’s total liabilities by its

shareholder equity. It is a measure of the degree to which a company is
financing its operations through debt versus wholly-owned funds.

Times interest earned ratio measures the extent to which the firm’s EBIT can
meet interest expenses. In general, the lower the ratio of such, the more firm
is burdened by debt expense.

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 EXAMPLE
The following is the Statement of Financial Position for Company A as at 31 March 2020:
ASSETS RM LIABILITIES AND RM
EQUITIES
Land and buildings 140,000 Share capital 200,000
Plant and machinery 350,000 Retained earnings 30,000
Inventory 200,000 Reserve 40,000
Account receivables 100,000 12% debentures 420,000
Other receivables 10,000 Account payables 100,000
Cash 40,000 Other payables 50,000
840,000 840,000
If the EBIT and interest expenses are RM84,000 and RM12,000 respectively, calculate:
a) Equity ratio
b) Debt ratio
c) Debt-to-equity ratio
d) Times interest earned ratio

a) Equity ratio = Shareholders’ equity / Total assets

= RM200,000 / RM840,000
= 0.23 @ 23%

b) Debt ratio = Total liabilities / Total assets

= RM570,000 / RM840,000
= 0.68 @ 68%

c) Debt-to-equity ratio = Long-term debt / Total equity

= RM420,000 / RM270,000
= 1.56 times

d) Times interest earned ratio = EBIT / Interest expenses

= RM84,000 / RM12,000
= 7 times

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 PROFITABILITY RATIO
Gross profit margin Net profit margin
= gross profit = net profit
sales sales

Return on assets Return on equity

= net profit = net profit
total assets total equity

Gross profit margin measures how much a firm earns from its revenue
less the cost of goods sold. It is also a measure of how much of each
ringgit of revenue of a firm is available to meet the non-product costs.

Net profit margin is a financial ratio used to calculate the percentage of

profit a company produces from its total revenue. It measures the
amount of net profit a company obtains per dollar of revenue gained.

Return on assets measures the profitability of a business in relation to its

total assets. This ratio indicates how well a company is performing by
comparing the net profit it’s generating to the capital it’s invested in
assets.

Return on equity refers to the return that common equity investors

receive on their investment. It represents the total return on equity and
shows the firm’s ability to turn equity investments into profits.

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 EXAMPLE
The following is the Statement of Comprehensive Income for Company A on 31 March 2020:

PARTICULAR RM
Sales 500,000
Less: Cost of goods sold (300,000)
Gross profit 200,000
Less: Expenses (216,000)
Net profit 84,000

If the total assets and total equity are RM840,000 and RM270,000 respectively, calculate:
a) Gross profit margin
b) Net profit margin
c) Return on assets
d) Return on equity

a) Gross profit margin = Gross profit / Sales

= RM200,000 / RM500,000
= 0.4 @ 40%

b) Net profit margin = Net profit / Sales

= RM84,000 / RM500,000
= 0.168 @ 16.8%

c) Return on assets = Net profit / Total assets

= RM84,000 / RM840,000
= 0.1 @ 10%

d) Return on equity = Net profit / Total equity

= RM84,000 / RM270,000
= 0.3111 @ 31.11%

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 EFFICIENCY RATIOS
Days sales turnover
= receivables x 365 days
01 02 sales
Inventory turnover
= sales
inventory
04
Total assets turnover
03 = sales .
total assets

Noncurrent assets turnover

= sales .
net noncurrent assets

Inventory turnover ratio measures the relative liquidity of inventories. It

describes the number of times a firm’s inventories are sold and replaced
during the year.

Day sales turnover measures the number of days it takes a company to collect
cash from its credit sales. This calculation shows the liquidity and efficiency of
a company’s collections department.

Noncurrent assets turnover determines the efficiency with which a business

uses its non-current assets to generate revenue for the business. Low non-
current assets turnover rate may indicate the business is not using its assets
effectively whereas a high turnover rate implies that business is more efficient
in using its non-current assets.

Total assets turnover is a ratio that measures a company’s ability to generate

sales from its assets by comparing sales with total assets. In other words, this
ratio shows how efficiently a company can use its assets to generate sales.

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 EXAMPLE

Based on the aforementioned information of Company A and if the total accumulated

depreciation for all noncurrent assets is RM51,000, calculate:
a) Inventory turnover
b) Days sales turnover
c) Noncurrent assets turnover
d) Total assets turnover

a) Inventory turnover = Sales / Inventory

= RM500,000 / RM200,000
= 2.5 times

b) Days sales turnover = (Receivables / Sales) x 365 days

= (RM100,000 / RM500,000) x 365 days
= 73 days

c) Noncurrent assets turnover = Sales / Net noncurrent assets

= RM500,000 / RM439,000
= 1.14 times

d) Total assets turnover = Sales / Total assets

= RM500,000 / RM840,000
= 0.595 times

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 MARKET VALUE RATIOS

02 03
RISK 01
04

80% 60% 50% 40%

Earnings per share Price earnings ratio

01 = profit after tax .
02 = price per share
03 Dividend yield
= share dividend x 100
number of shares issued earnings per share price per share

Earnings per share measures the amount of net income earned per share
of stock outstanding. In other words, this is the amount of money each
share would receive if all of the profits were distributed to the
outstanding shares at the end of the year.

Price earnings ratio indicates how much investors are willing to pay per
RM of earnings in a firm. Hence, firm with high P/E ratios are generally
taken as firms with bright future prospects.

Dividend yield is a financial ratio that measures the annual value of

dividends received relative to the market value per share of a security. In
other words, the dividend yield formula calculates the percentage of a
company’s market price of a share that is paid to shareholders in the
form of dividends.

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 EXAMPLE

a) A business reports RM80,000 of income after tax. The number of common shares
outstanding during the period was 1,000,000 units. Calculate the earnings per share.

b) ABC International's common stock is currently selling for RM15 per share on the open
market. It reported RM3 of diluted earnings per share in its last annual report. What is
the price earning ratio for ABC International.

c) ABC Company pays dividends of RM10 per share to its investors in the current fiscal
year. At the end of the fiscal year, the market price of its stock is RM80. Calculate the
dividend yield.

a) Earnings per share = Profit after tax / Number of shares

= RM80,000 / 1,000,000 units
= RM0.08 per share

b) Price earning ratio = Price per share / Earnings per share

= RM15 / RM3
= 5 times

c) Dividend yield = (Share dividend / Price per share) x 100

= (RM10 / RM80) x 100
= 0.125 @ 12.5%

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 LIMITATIONS OF RATIO ANALYSIS

Inflationary effects Operational changes Manipulation of FS

Historical information Changes in policies Seasonal effects

• Information used in the analysis is based on real past results that are
released by the company. Therefore, ratio analysis metrics do not
necessarily represent future company performance.

 Financial statements are released periodically and, therefore, there are

time differences between each release. If inflation has occurred in
between periods, then real prices are not reflected in the financial
statements. Thus, the numbers across different periods are not
comparable until they are adjusted for inflation.

 If the company has changed its accounting policies and procedures, this
may significantly affect financial reporting. In this case, the key financial
metrics utilized in ratio analysis are altered and the financial results
recorded after the change are not comparable to the results recorded
prior to the change.

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 When significant operational changes occur, the comparison of financial
metrics before and after the operational change may lead to misleading
conclusions about the company’s performance and future prospects.

 The inability to adjust the ratio analysis to the seasonality effects may lead
to false interpretations of the results from the analysis.

 Information in financial statements may be manipulated by the company’s

management to report a better result than its actual performance. Hence,
ratio analysis may not accurately reflect the true nature of the business, as
the misrepresentation of information is not detected by simple analysis.

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THANK YOU

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 CLASS EXERCISE
Amanda Bakery Sdn Bhd, and Amani Bakery Sdn Bhd, are rivals in the food industry. The
following are financial statement figures for each company.

Item Amanda Bakery Sdn Bhd Amani Bakery Sdn Bhd

RM RM
Total assets 30,000,000 30,000,000
Total equity (all common) 27,000,000 15,000,000
Total debt 3,000,000 15,000,000
Annual interest 300,000 1,500,000
Total sales 75,000,000 75,000,000
EBIT 18,750,000 18,750,000
Net income 11,070,000 10,350,000

Required:

a) Calculate the following ratios for both companies:

i. Debt ratio
ii. Net profit margin ratio
iii. Return on assets ratio
iv. Return on equity ratio
b) Times interest earned (TIE) ratio
c) Based on your answer in (a), make recommend which company has
better financial performance in terms of debt management and
profitability.
d) As an investor, which company do you interested to invest your
money. state your reasons.

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 CLASS EXERCISE
The financial manager of Jean Perry Sdn Bhd, a manufacturing firm, has decided to seek a line of
credit from a local bank. This additional source of funds is needed to support a large portion of the
firm's accounts payable during the next three months, which are the firm's peak seasonal sales
period.
The industry average ratios are provided below to facilitate an analysis of the firm's loan request:
Industry Average Ratios
Current ratio 1.80 times
Quick ratio 0.70 time
Inventory turnover 7.0 times
Average collection period 20 days
Fixed assets turnover 1.80 times
Total asset turnover 1.20 times
Debt ratio 50%
Times interest earned 8.5 times
Gross profit margin 22.0%
Net profit margin 12.0%
Return on assets 10.0%
Return on equity 20.0%

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The firm's most recent financial statements were presented to the bank in support of its loan
request as follow:

Jean Perry Sdn Bhd

Statement of Comprehensive Income for the year ended 31 December 2019

RM RM
Sales (all credit) 2,400,000
Less: Cost of goods sold (1,840,000)
Gross profit 560,000
Less: Operating expenses 120,000
Depreciation expenses 120,000 (240,000)
Earnings Before Interest and Tax 320,000
Less: Interest Expenses (40,000)
Earning Before Tax 280,000
Less: Tax (25%) (70,000)
Net income 210,000

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 Jean Perry Sdn Bhd
Statement of Financial Position as at 31 December 2019
RM RM
Net non-current assets 1,080,000
Current assets:
Cash 56,000
Marketable securities 31,800
Account receivable 125,000
Prepaid rent 20,000
Inventories 336,000 568,800
Total assets 1,648,800
Current liabilities:
Account payable 228,000
Notes payable 42,000
Accruals 30,000
Total Current liabilities 300,000
Long term debt 500,000
Ordinary share equity 600,000
Retained earning 248,800
Total liabilities and equity 1,648,800

Required:

a) Compute the above ratios for Jean Perry Sdn Bhd for 2019.
b) Based on your answer in (a), make a competitive analysis on the
financial performance of the company compared to the industry.
c) Should the loan be approved? State your reasons.

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 CLASS EXERCISE
Below are the financial statements of Rendezvous Sdn Bhd for the financial year ended 2019:

Rendezvous Sdn Bhd

Statement of Comprehensive Income for the year ended 31 December 2019
RM
Sales 5,432,000
Less: Cost Of Goods Sold 1,630,000
Gross Profit 3,802,000
Less: Operating expenses 570,000
Earnings before interest and taxes 3,232,000
Less: Interest expense 632,000
Net Profit before taxes 2,600,000
Less: Taxes (24%) 624,000
Net profit after taxes 1,976,000

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 Rendezvous Sdn Bhd
Statement of Financial Position as at 31 December 2019

RM RM
Net Non-Current Assets 1,170,000
Current Assets:
Cash 465,000
Account receivable 281,000
Inventories 805,000
Marketable Securities 189,000 1,740,000
Total Assets 2,910,000
Current Liabilities:
Account payable 245,000
Accruals 514,000
Note payable 321,000 1,080,000
Long term debt 387,000
Ordinary shares 493,000
Retained earnings 950,000
Total Liabilities and Shareholder’s equity 2,910,000

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 The industry average ratios are provided below to facilitate an analysis of the firm’s loan request:
Industry Average Ratios
Current ratio 1.9 times
Quick ratio 1.0 times
Net profit margin 40%
Return on equity 45%
Debt ratio 55%
Inventory turnover 8 times
Day sales outstanding 25 days

Based on the above financial statements:

a) Compute the above ratios for the year ended 31 December 2019.

b) Based on your answer in (a) comment your findings in comparative analysis on leverage ratio
and assets management ratio compared to the industry average.

c) Do you think invest in the company is worthy? State your reason.

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